Retaining retail inflation at 4% an unaccomplished dream since 2019-20

The target was achieved in the first two and a half years of implementing inflation targeting in Oct 2016, but the inflation rate remained above the goal

Though six per cent retail inflation is the upper tolerance level for the Reserve Bank of India (RBI), it is the four per cent mark the central bank strives to achieve. But it eluded the RBI most years since inflation targeting was introduced from October 2016.

The target was achieved in the first two and a half years of implementing inflation targeting, but the inflation rate remained above the goal.

However, the rate was only slightly higher at 4.76 per cent in 2019-20. Since then, it has been way off the mark. In fact, it breached the comfortable level of six per cent in two years -- coronavirus-induced lockdown years of 2020-21 and 2022-23.

In his new prelude to the book -- Quest for Restoring Financial Stability in India-- former RBI deputy governor Viral Acharya

writes that the central bank needs to deliver inflation prints around the mandated target of four per cent for several years to ensure domestic and external financial stability.

"It would be good for India, its common man, and its domestic and external financial stability, if the Reserve Bank were to revert credibly and soon, to delivering realised inflation prints that average around the mandated target on a durable basis, that is, for several years," he writes.

Otherwise, he warns that gains from adopting inflation targeting, such as permanent lowering of inflation expectations and long-term borrowing costs will not fully materialise.

Acharya also reminds analysts and bond markets that the retail inflation target for the central bank is four per cent and not six per cent. Hopes around six per cent make it difficult to contain inflationary expectations, he cautions.

"Public commentary, analyst sighs of relief or cries of concern, and bond market expectations are now all centred around 6 per cent, the upper limit of the band around the consumer price inflation target for the Reserve Bank, rather than at the target of 4 per cent. This suggests that inflation expectations risk becoming unanchored," he says.

The government has mandated the RBI to keep the consumer price index-based inflation rate at four per cent plus or minus two per cent.

Acharya says in the footnote that the +/- 2 per cent band around the target headline inflation rate of 4 per cent was meant to account for inevitable measurement noise in inflation rather than to allow the MPC and its Reserve Bank members to shift around the focal point of monetary marksmanship.

RBI governor Shaktikanta Das has also been saying that the central bank is committed to a four per cent inflation target.

Last month, he again talked about the central bank's unflinching commitment to achieving a 4 per cent inflation target, despite the frequent incidents of food price shocks.

Delivering the Delhi School of Economics (DSE) Diamond Jubilee Distinguished Lecture on 'Art of monetary policy making: The Indian Context', Das underlined the RBI's vigilant stance against secondary effects of food price shocks and its dedication to preserving price stability through timely actions.

Generally, food items drive the inflation rate beyond six per cent. This is so because these articles have 39.06 per cent weight in the consumer price index (CPI). Along with beverages, these items constitute 45.86 per cent of the index.

However, this is not always the case. For instance, food inflation stood at just 3.8 per cent on average in 2021-22, even then overall inflation was 5.51 per cent. This was so because fuel and light inflation was in double digits at 11.3 per cent and high core inflation (those relating to items outside food and fuel).

The next year, fuel and light inflation remained in double digits, though dropping marginally to 10.3 per cent. However, food inflation rose to 6.63 per cent. This had pushed the overall inflation rate to 6.66 per cent.

In the first five months of the current financial year, fuel inflation came down to just 4.4 per cent. However, food inflation was high at 6.56 per cent. As such, the overall inflation remained high at 5.63 per cent, though below last year's mark because core inflation has come down. The fuel inflation is low despite high global crude prices since the oil PSUs have refrained from raising petrol and diesel prices ahead of elections. In fact, LPG cylinder prices were cut by Rs 200 from August 30, the full impact of which is yet to come in September data. The government also raised commercial cylinder prices by Rs 209 from October, but its repercussions are yet to be fully felt.

Das had recalled, "So when the inflation target was to be reviewed in early 2021 and notified for the next 5 years, the Reserve Bank reiterated and recommended for retention of the 4 per cent target. It was stressed that the target and the flexibility built around it had helped us to support the economy when required and shift gears and re-prioritise inflation over growth if inflation became high and breached the upper tolerance level of 6 per cent."

The country adopted inflation targeting from October one, 2016 whereby the RBI has to contain inflation in the four per cent plus, minus two. This means the inflation has to be contained in the range of two-six per cent. The target was reviewed and retained at that level for five years from 2021-22 onwards.

If the RBI fails to meet the lower or upper end of the range for three consecutive quarters, it has to write to the government explaining the reasons behind its failure and give a timeline by when the rate would come back in the range. The central bank wrote to the government about this when the average inflation was above the upper tolerance level of six per cent for three consecutive quarters during January-September 2022, but its contents were not made public.